How long until China cranks up the debt engine?

Growth was 6.8 % in the first quarter, the government announced Tuesday, just a hair lower than in 2017 as a whole. Key indicators like electricity output and construction investment ticked up as companies took advantage of easing seasonal pollution restrictions.

But beneath the seasonal thaw, there are hints the long winter did real damage.

Retail sales ticked up in March, but in services and construction, the purchasing managers’ employment index hit a five-month low. More worrying, real borrowing costs for industrial firms are rising quickly again.

Higher U.S. inflation and rates, slowing trade, and renewed debt defaults at home could pose a tricky problem for Beijing by late 2018: Ease up on the “deleveraging” drive to help struggling firms stay afloat and keep growth around current levels, or allow borrowing costs to remain high to contain long term risks and capital outflows.

China’s central bank has already begun to quietly moderate its hawkish stance. After the last two U.S. rate hikes, it has “pretend[ed] to follow the Fed,” raising interbank rates by only small amounts while actual market interest rates in China remain much higher, said Julian Evans-Pritchards of Capital Economics.

A quick look at China’s lending market shows why. Real yields on AA-rated corporate bonds—issued mostly by industrial and real estate companies—rose to nearly 3 % in the first quarter, according to Thomson Reuters, while real bank loan rates likely hit 2%. Those rates are still far below the 7-10 % levels seen when debt defaults peaked in early 2016. But if producer price inflation keeps slowing—it hit a 17-month low in March—real rates could be in that neighbourhood by early 2019.

The key question appears to be how deep and effective China’s much-celebrated “supply side reforms” have really been. If enough excess capacity has been eliminated and housing inventory sold down, then producer price inflation will remain healthy and Beijing would not need another massive stimulus to push prices back higher and stave off defaults.

Otherwise—and particularly if a true trade war seriously disrupts exports—the chances of another big debt splurge next year will rise significantly. That would probably mean a commodities buying opportunity, but be negative for China’s long-run prospects.

Either way, it is likely to be a trickier next twelve months than indicated by the April 17, 2018 smooth growth figure.